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| Home > Options Spreads > Put Spreads |
Put Spreads |
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Put Spreads Day - DefinitionPut Spreads are options strategies constructed using Put Options only. Put Spreads - IntroductionPut Spreads are a group of options strategies consisting of buying and writing two or more different Put Options in order to achieve specific payoff profiles. Even though Put Spreads are made up of only Put Options, Put Spreads are capable of profiting not only when the price of the underlying stock goes downwards but there are also Put Spreads that profit when the underlying stock goes sideways or upwards. Yes, such is the versatility of options trading.
What are Put Spreads?A Put Spread is any options strategy that: 1. Consist of Put Options only Depending on the way the Put Options are put together, Put Spreads can be designed to profit not only when the underlying stock goes down but also when the underlying stock goes sideways or upwards. Indeed, Put Spreads are not always bearish options strategies. They can also be bullish or neutral as well. This is due to the fact that Put Options not only profit when the underlying stock goes down when you buy them but also profit when the underlying stock remain stagnant or goes upwards when you write them.
Why Use Put Spreads Instead of Just Put Options?So, why use Put Spreads instead of simply buying or writing Put Options since doing so also allows you to cover all three directions? The main reason why Put Spreads are used by options veterans instead of just simple Put Options buying or writing is for the purpose of hedging and lowering margin requirements. The most basic Put Spreads typically writes an additional Put Option on Put Options bought or buys an additional Put Option on Put Options written. Doing so partially hedges against capital risk by lowering the cost or margin of the position and hedges away the unlimited loss potential of a short Put Options position. In fact, there are Put Spreads that so completely hedges against upside risk that a Put Options position can be designed not only to profit when the underlying stock goes down but also to make a small profit when the underlying stock goes up! Classification of Put SpreadsPut Spreads can be broadly classified as Vertical Put Spreads, Horizontal Put Spreads or Diagonal Put Spreads in options trading, based on the relative moneyness and expiration date of the Put Options used in the position. Horizontal Put Spreads are Put Spreads that consist of Put Options of the same strike price but different expiration months. Horizontal Put Spreads are usually Put Calendar Spreads or Put Time Spreads. Diagonal Put Spreads are Put Spreads that consist of Put Options of different strike price and expiration months. Diagonal Put Spreads include Diagonal Put Calendar Spreads. Of course it isn't important nor necessary to know these classifications in order to trade Put Options so options trading beginners need not put too much emphasis on this part. List of Popular Put SpreadsHere is a list of the most popular and most commonly used Put Spreads in options trading: Bear Put Spread : A Bearish Put Spread consisting of buying at the money Put Options and writing out of the money Put Options in order to lower cost. Bull Put Spread : A Bullish Put Spread consisting of writing at the money Put Options and buying out of the money Put Options in order to lower margin requirement and hedge against unlimited risk. Ratio Bear Spread : A put spread that makes a small profit when the stock goes upwards and achieves its maximum profit when the stock goes downwards to a certain price limit. Put Butterfly Spread : A complex neutral put spread consisting of writing at the money Put Options and buying in the money and out of the money Put Options against it. Put Condor Spread : A complex neutral put spread similiar to the Put Butterfly Spread but writing slightly in the money and slightly out of the money Put Options instead of at the money Put Options. Put Time Spread : A complex neutral put spread consisting of buying long term Put Options and writing short term Put Options against it. Put Ratio Backspread : A complex volatile put spread consisting of buying at the money or out of the money Put Options and writing in the money Put Options against it. Advantages of Put SpreadsAs you can see above, there are Put Spreads for every market outlook; Bullish, Bearish, Neutral or Volatile. This is some which merely buying or writing Put Options individually cannot achieve. By putting together long and short Put Options of different options moneyness or expiration, the risk profile of a Put Options position can be modified or designed to reach maximum profitability at specific prices and keep maximum loss within a pre-determinable limit. Disadvantages of Put SpreadsThe main disadvantage of Put Spreads is the additional commissions incurred by the additional legs involved in each position. Put Spreads that limit maximum potential profit could also cause you to make lesser profit than you should have if you have simply bought Put Options instead if the underlying stock should fall strongly. The other disadvantage of Put Spreads is that short legs need to be held all the way to expiration for their full value to be realised. If a position is closed early, the short legs could in fact appreciate, causing you to buy back the short legs at a higher price, reducing your profits and incurring additional commissions. As such, if you are trading an extremely short move, you should consider using Put Options that are very near expiration or not use Put Spreads at all.
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